Global Imbalances: The Adult Within Her

Macarena is not one to miss a chance to revive the joys of her fairy-tale childhood. So she is only too happy about the way grown up guys argue on whether the economy is “Goldilocks” , “Three Bears” or whatever…. So much more satisfying than the “hard landing” , “soft landing” nonsense…. Macarena and her girlfriends, let me tell you, are fed up with the hard/soft dichotomy!!
Anyway, a few recent papers have sharpened the adult within her, spoiled her fun, and put her in the ever so boring “thoughtful” mode. Instead of something like the Cinderella economy, or the tic-tac-toe carry-trade, which she has been toying with, along comes a mature, suggestive, concept like…. (gulp)… Asset Shortage.
Global imbalances, along with other established stylized facts of the last few years, you see, can be usefully thought of as market solutions to problems that have roots much deeper than the stupidity routinely attributed to policy practitioners by desk-top Monday morning quarterbacks. Namely, the fact that asset demand has been growing at a very strong rate, while asset supply has been constrained by a combination of institutional limitations, and changing fiscal realities..
Demand is growing strongly. Among other reasons, the current account surplus in many countries, (i.e what Chairman Bernanke has dubbed “savings gluts”), the need to collateralize and diversify the enormous credit risks originated in the last few years, the need to match the ageing process and other demographic realities with specific financial instruments, and so on.
Supply, on the other hand, is insufficient overall, because not all potential issuers are credible enough to play in the big leagues. Why does your typical central bank demand such a narrow set of asset classes when investing reserves? Sure, there are many compelling reasons, please don’t bother to list them. But think hard about these reasons. Would it not make sense for the Reserve Bank of India to invest its reserves in Infrastructure projects instead of U.S Treasury bills, as has recently been proposed?
The reason why the Indian proposal was received with such yawn among the knowledgeable are understandable: claims on investment projects are a poor support for the Rupee, period. There are serious operational and technological limitations in the development of the market in which a potential claim on infrastructure cash flows would trade. There are liquidity limitations that might seriously affect the reserve management strategy implemented by the RBI. There are sovereign risk considerations. And so on and so on. Many more savers, aside from the RBI, will also prefer assets issued by the U.S Treasury over assets issued by the Indian Infrastructure Fund, and will do so for similar reasons. Important investment projects continue to fail in delivering the type of financial claims required by big leaguers, like the RBI, despite having very promising cash flows.
Supply is also below requirements for another reason: the recent fiscal adjustment in many economies. We are now used to governments routinely announcing lower deficits, yet another debt buyback, and so on. Policy observers the world over, ever more stern in their calls for fiscal muscle, have seemingly not noticed that, according to a recent estimation, the total stock of sovereign debt outstanding has been constant, at about 75% of GDP, since 1996. In other words, not only is there an institutional constraint hindering admission to the big leagues, but also a reluctance to issue within the middle and even the little leagues.
When coupled with the development of global financial markets of the last decade, a fascinating process which has implied a surge in the demand for more and for ever more diverse assets, this mature, very adult, supply-shortage story makes enormous sense to Macarena. She is now trying to figure out a cute way to call it. How does “Gilligan’s Island economy” sound?